Canadian real estate is overvalued. That’s a general statement, it doesn’t mean you can’t find an investment property, it just means finding one is going to be difficult. If you’re a home buyer though, I’d be worried.

For the last 20 years, money has been getting cheaper and cheaper to borrow. This means the “average” person is able to afford the costs associated with borrowing more money to buy things.

The intended purpose of this, according to the government, is to stimulate the economy by getting people to spend money, thus create a demand for good, which keeps people employed…etc.

Of course, following the law of unintended consequences, we’ve managed to create a real estate bubble. People who once couldn’t afford to buy a house (when interest rates were 8–14%) could now afford a “starter home”, people who could afford a house before, could now afford a bigger house (ever hear a realtor tell you to “buy the most house you can afford”?). All this put pressure on the existing market (strong demand, limited supply), so prices went up. No big deal, as long as you could afford the payment.

When this all started, nearly 20 years ago, money slowly fell from an historical 8% average rate to today’s sub-3%. The bank’s overnight rate (the money banks lend at to one another, has been at 1% for a long time, but last week fell another .25% to sit at the unheard of rate of 0.75%).

The feds have been hinting that they want to raise this rate, but I think they realize that they’ve dug themselves a deep hole…with no way to reach the top, so their solution is to keep digging and hope they can come out the other side. Not a good plan.

Why can’t they raise the rates?

Mortgages in Canada are usually locked in for 5 years (most popular package). For 5 years, you know what your payments are going to be, and you should be pretty sure you can afford them at the time you sign the contract. You’re confident that, having bought “the most house you can afford”, that someday it will truly be yours…

Except, a good rule of thumb is, for every 1% interest rate increase, your costs of borrowing will increase nearly $100/month for every $100,000 you’ve borrowed. You have a $500,000 mortgage, come renewal time if interest rates rise 1%, expect to pay an extra $500/month, if they go up 2%, expect $1000/month. Ouch!

But, 1% is a big increase right?

In the short term yes. The feds usually only raise/lower rates by .25%, maybe .5%…but remember, in real estate, we think in terms of years. If the feds only raise rates .25%/year starting the year you lock in your mortgage, in 5 years, when you go to renew, interest rates will be 1.25% higher! Also remember that the feds usually adjust more than once a year.

Well, you can always sell and cash out on your equity right?

Except, you won’t be the only person in that situation…these numbers will affect everyone trying to renew…and they’ll probably all have the same idea. Suddenly the supply hitting the market will start to increase…add to that the fact that money isn’t quite as cheap anymore. Potential buyers are going to face the same problem you are trying to get out of…they can’t afford the price of the house!

That’s when the bubble will burst and the housing market will go over the cliff.

For now, the distance to the cliff has moved further away with the rate drop, but it will suck in more people. At some point the music is going to stop and a lot of people are going to get caught holding the bag.

If you can, I’d be trying to get your borrowing down to a level you can afford at much higher rates. Your home’s equity is going to take a pounding when this happens, but it’s better to lose paper profits than lose your house.

Lesson: Cheap money is driving up prices, not value. With the rate drop, you get more time to save or hang yourself. Make the right choices.

When people look at my background (multiple business owner, self employed, investor, real estate, family, volunteering, etc) they tend to assume I’m a very busy person. The media is full of the “you must commit every moment of your day to achieve success” message.

When I started, that was probably fairly true, I worked quite a few hours when I was starting, but I was younger, had nothing better to do, and liked working. Back then, it probably related to my early success…there’s nothing wrong with a good work ethic.

What I really find interesting though, looking back, is that my real success came from not devoting my entire life to success. When I was injured, I could no longer devote a lot of time to working. Physically and time-wise (doctors and treatment really eat up your time), it was no longer possible. Now, initially, this had a huge impact on my business…I had to unlearn the old ways of making money I’d been taught and learn new ways tat didn’t involve so much of “me”.

Those lean years put a lot of pressure on me and my family, pressure that was not good in any way physically, mentally or emotionally. There was always a driving force to not screw up, to push myself to the limits, to get things done…it changed me, threatened to consume me. This attitude continued on past the “dark times” until one day I realized it. Until then, I couldn’t see the panic that was driving me, I could feel it’s effects though in a short temper, poor sleep, increased pain, etc. At this point, I did something truly radical…I stopped.

Yes, right in the middle of a project, I stopped, put my feet up, sat back, and realized that I was sitting in the middle of a field on a gorgeous summer day…I don’t think I was even aware of that fact until that moment. It was not an easy thing to do…I’d been driven for years, pushing myself to my meagre limits but, as I sat there, I realized that the earth didn’t come to an end. My years of smart investing had made us fairly secure, my businesses had been modified to our new reality…thing were, in a word, fine.

There was still a lot of things waiting to be done, but the truth was they could wait a little longer. Nothing died if they weren’t addressed today, or even tomorrow.

In truth, I don’t remember a lot of my life during the “dark days”, it’s all quite a blur…even though it represented a significant portion of my life. It’s sad to have lost so much “living” time, time devoted only to existing, making money, surviving…

Since my realization, changing my attitude hasn’t been easy…but each day it gets a little easier to “let things go”. I spend a lot of time with my kids and family. I look for excuses not to work, and when I do work I devote all my focus to get it done properly and efficiently so that it’s over as soon as possible and won’t have to be redone later.

With my investments, I hardly look at them anymore…I’ve always been a buy and hold type of investor, so why bother watching them daily. You know what, they’ve all been going up quite nicely.

With my real estate, I’ve stepped back a lot. I still enjoy looking and negotiating for properties, but I now hire people to fix the places, and may even hire a manager to take care of the tenants…the foundation I build allows for it.

I don’t need to squeeze every penny out of my investments, the more I spread the wealth, the more time I’ve got to find ways to make more.

I think too many people get too focussed on to narrow a vision. The more I’ve stepped back to spend time for myself and my family, the more my net worth has grown…but I measure my success more in terms of my relationship with my wife and kids. I’ve got a strong family, and I get to live with them everyday, I’m not just someone who exists in their life.

I’m off now to bake cookies with them.

Lesson: The message of “devote yourself” to be successful isn’t true. Living is success…dying with the most stuff isn’t.

As an owner of a design company, you have to own a lot of fonts. When I started out, I had hundreds, if not thousands. Over the years, I’ve acquired many more to the point that I now have over 25,000. Some people may think this is a good thing but, in reality, it’s more of a mixed blessing.

It’s very useful when new clients come with legacy products, because there’s a good chance I have their font already. The problem comes when designing something new, there are just too many fonts to go through, so chances are we stick with the main ones we use a lot.

Ironically, by having more options, we’ve actually become more limited.

The internet has become like that as well. In the early days, I probably visited the entire internet weekly (that was a while ago, and it was significantly smaller). Today, there are more pages being added daily, than I could probably visit. As a result, I find that the number of sites I visit has drastically reduced to a handful. Rarely do I just browse around anymore. The only time I search the internet is when I’m looking for specific information. The information on the internet is full of junk, not worth the time to read. Sorting the truth from the trash is getting to be too much work.

Ironically, every business needs a website to be legitimate in the eyes of it’s customers, yet less and less people are simply browsing. I’m not even sure if any human eyes ever read these words…and I’m too lazy to look through the log files to find out.

I suppose the same barrier exists in real estate investing. There are so many places for sale out there, most overpriced, that many investors have simply given up looking. Too many duds to sort through…and there lies the opportunity.

To cope with information overload, you need to narrow down your options. For the fonts problem, the solution is to set aside time each day to go through and look at each font, evaluate them a few at a time, and pick out a useful set of them. Initially, it may take months to reduce 25000 down to 1000 or less, but after that is done the work becomes easier. Once a year you can review this 1000, and reevaluate them. As you add fonts, you can decide if they are long term use, or one shot deals.

With the web, I’ve got the handful of sites I frequent, once in a while I stumbled across something new to add. Ironically, this is usually done through word of mouth, not searching.

Finally, with real estate, I work with my agent to provide me with a notification of properties which meet a very strict set of criteria. That criteria doesn’t tend to provide a lot of hits in this overpriced market, but it’s dangerous to be desperate in investing. I’d rather wait for the right property than buy the wrong one just to be in the market.

Lesson: Too much information can limit you. Best to trim down the volume to something manageable to make yourself effective.

A friend of ours recently came by for a visit. They are interested in starting their own business, and inspired by our apparent success.

It’s very easy to look at our life and think it’s easy to duplicate. The truth is, we’re not even close to an overnight success. Business and investing is not a get rich quick scheme. True, it does happen, but so does winning the lottery.

When we started our equestrian business, my wife started by teaching on other people’s properties, one or two lessons a week. The cost of owning a lesson horse was higher than her income. As she acquired more students, we invested in more horses, equipment, etc.

As time passed, a wide variety of opportunities presented themselves opportunities. These ranged from employment opportunities, to programs we could implement, different things we could attempt, etc. As each opportunity arose, we had to evaluate each one for their long term implications. These choices aren’t always easy to make. Do you take the security of a steady income over the potential greater benefits of developing your own business?

Sometimes, the choices we made lead down a dead end path, other times it didn’t. Being able to recognize the difference and being willing to change is the difference between success and failure. Every once in a while, several times a year, we’d take time and look at what we were doing, and look for ways to improve.

Investing is a similar process I’ve found. I don’t invest the same way today as when I started, I’ve learned more, and continue to learn on a daily basis. While my basic philosophy hasn’t changed (I still buy Real Estate using the techniques I wrote about in my book), I’ve fine tuned the process, and I have much more experience than I used to. Of course, this doesn’t mean I don’t look for other methods. I instantly talk to other investors who flip, buy land, buy houses, etc.

Of course, I didn’t start off buying multiple houses, I started out with just one. Over several years, I slowly acquired more, learning from each purchase and tenant. Now I’m at a different stage, one that allows me to buy multiple properties in a year.

Someone who meets me today, thinks I was an overnight success, when the truth is I’m a success because I’m able to take the long term view. and I had the patience to wait for it. I never tried to force success where none was possible. If something didn’t work, I was willing to change it.

With years of slow building, rapid success can appear to happen quickly. When we opened our stable, we came with multiple years of experience, and a base group of students which ensured that starting our business would stand a good chance of success. What many forget is the 15 years it took to build up the base for that success, or all the years of experience we’ve gained.

The business and real estate didn’t make money right away, in fact they probably lost money for years. The trick is to limit the losses until the potential of the investment could pay off.

Many businesses fail because they are unwilling to pay the price, others will fail because they refuse to change course when things aren’t working. Don’t be fooled into thinking others are an overnight success, many of them have been building up their success for years.

Lesson: Most people don’t hit the lottery in life to succeed, they get there by building up a foundation.

Canada’s real estate market is overvalued. Anyone who says otherwise is lying to you and living in a dream world. Fuelled by low interest rates, which allowed more people the ability to buy, housing prices have risen at an unprecedented rate over the past 10–15 years as demand, and affordability, increased.

You may wonder how I can say affordability can increase along with prices, but as I said, it’s fuelled by lower interest rates. Back when I bought my first house, interest rates were around 8%, and we counted ourselves lucky. I remember my sister paying upwards of 20% during the 80’s (only 30 years ago). Back then, with those interest rates, a $100,000 cost upwards of $1,500/month just for the mortgage (based on 20% interest, 5 year closed, 25 year (max back then) amortization. Today, that same $1,500/month can buy you a place for around $375,000 (based on 3%, 5 year closed, 30 year amortization). Does that mean you’re getting 3 times the house today? Nope, in fact, it’s probably a lower quality house, but demand has driven up the price. When people have cheap money, people buy based on what they can afford. $1,500 today is a lot less than it was 30 years ago (today it’s equivalent to about $3,500 which would let you buy an $850,000 home), so more people can afford to get into housing.

The numbers today are high, but with low interest rates, people can afford to buy and pay more. The scary moments come, of course, when you hit bottom. Can interest rates continue to fall? Not likely, since we’re getting close to zero. So, no more fuel for the fire. The government has hinted they’d like to raise them, but I think has realized that they can’t do it quickly.

The solution? First off, stem the flow of fuel. A few years ago, if you had a pulse, you could get a mortgage. Remember, banks make a fortune off of lending money (they leverage their lending, so they make between 10–20 times what they loan out, that 3% is actually between 30–60% return). Anyone who’s applied for a mortgage lately knows it’s like pulling teeth to get approved now due to government regulations. The government is trying to slow the amount of money available at these low rates. The less people who owe at these lower rates, the less that suffer when the rates increase. Remember, for each 1% increase in the interest rate, your payments increase about $100/month for EVERY $100,000 you owe. After your first 5 years of scraping by to come up with $1,500/month to pay your mortgage of $375,000, imagine having the shock of your payments going up by $375-$750/month just because interest has risen 1–2% in that time. This isn’t temporary either, it’s for the next 5 years after which it will probably increase again.

This is why I think the market will eventually collapse. The increases in costs are staggering for relatively small moves of the interest rate. People will lose their houses because they can’t afford them, and they won’t be able to sell them because the market will be flooded with all the other houses in the same boat. If interest rates rise quickly (and, by that, I only mean 1–2% over 5 years) foreclosures will be commonplace.

Early signs

There was a period of about 5 years where I didn’t make a single real estate purchase. There was absolutely nothing which met my criteria as prices rose at a ridiculous rate. That all changed a few years ago. Suddenly, after the financial crisis and real estate meltdown in the USA, a handful of places started to trickle onto the market which were priced at a rate I could make money with. Funny thing is, no one was buying. I think most investors had given up looking after such a long drought.

Since then, the market has been doing funny things…all the places I’ve bought recently are worth more than I paid for them (as least that’s what the market seems to say, I won’t know for sure unless I try to sell), but at the same time, there are new opportunities coming onto the market at even lower prices. I recently saw a two bedroom condo come on the market at an unheard of $57,500.

I know the complex it’s in, having looked at units in the same buildings (and passed on them) before I know it’s got a lot of issues, and it wouldn’t attract a quality tenant, but at that price…even I had to think hard about it. There’s a reason the place is cheap, but what’s disturbing is similar units have been listed higher in the same complex for years…the bottom of the market is definitely slipping. a few years back, nothing listed anywhere for under $100,000, even units in this complex. Today, there are two bedrooms listed at half that amount, and not selling…

Should you be buying today? Hard to say…I have been (not ones like that), you may not be able to. For instance, one of the reasons that unit is so cheap is most banks are refusing to grant mortgages based on the address. Too many places in the complex are going into foreclosure… I think patience is the key. Pick good properties, in good locations that will cash flow for you in a bad economy. They are still few and far between, but they are out there. Don’t buy just because it’s cheap, soon (in real estate terms “soon” is measured in years) there will be a lot more available.

Banks are refusing to issue loans, prices are moving, interest rates need to rise…the future doesn’t look rosy for homeowners. Then again, more people losing their homes will put even more pressure on the rental market…

Lesson: Something is happening, it’s disturbing to me that the bottom of the market is slipping. If the government is smart, unlikely I know, they will try to soften the coming crash. We’re in for a rocky road, but for the brave and patient, there are profits to be made.

Many people tell me it’s impossible to be a landlord. There’s just no way to make money, tenants are nightmares, they don’t want the hassles…whatever.

I suppose, I also hear the same thing about starting a business. 9/10 businesses fail within 3 years, you have no life, it’s all work and no play…etc.

Having started a few businesses, helped out many startups, and having been successful in real estate, I know this just isn’t true. I also have learned that most people can’t do it. They don’t think the right way.

Now, this is true even in the same family, no one else in my family is self-employed (though several have tried it and failed), and none of them have ventured into investing farther than a mutual fund (and most of us know how successful that can be).

Business is a way of looking at the world. When I encounter problems, I look for solutions, usually ones which don’t involve money. Many people believe that the phrase “it takes money to make money” means you need to throw money at a problem to solve it…

Property doesn’t cash flow? Make a bigger downpayment. Product not selling? Spend more on advertising. Profit goals not met? Time for cutbacks.

True, most of these solutions will work, at least short term, but they all ignore the fundamental problems. You’re trying to cure a disease by treating the symptoms. This may work, but you’d be more successful if you know the disease and treat it.

In real estate, so many people what to get in on the market at it’s peak, and interest rates are low. A friend of mine bought a 500 sq.ft. bachelor suite for $107,000 and couldn’t figure out why they didn’t make money off it, since real estate is such a good investment.

I know someone who started a company, bought new equipment, rented an office, spent a lot on business cards, a website, brochures…but never did anything else. They sat in their office every day, waiting for customers to flock to them…but no one came, since they didn’t tell anyone they existed. They were waiting for the internet to bring them money.

A friend of mine published a book, and rather than going with print-on-demand, or e-books, they went to a printer and ran off 5000 copies at their expense. 5000 copies is considered a best seller in Canada, how many best selling Canadian authors do you know? Now, how many of those don’t have the backing of a publisher to get it into stores, promote it, etc? I think, the last I heard, they were still working on selling their first box of books years later. Of course the printer, who talked them into printing the books, is still in business.

To be successful in business or investing, you need to set boundaries which you know can succeed. I’ve got price ranges for properties that I look for, and a bachelor over $100,000 isn’t in that range. True, they are selling at that price, but I know, as a landlord, that I can’t make money at that price over the long term. If I can’t find something in my range, I need to wait. Waiting is hard to do in business…others are getting rich around you, you feel like you’re being left behind…but then you’re probably not looking at all the facts. People who bought real estate years ago, when prices were significantly lower, are making a killing…but back then bachelors were going for $25–30,000.

You can’t force the market to give you money just because you want it. When I started out in business, I didn’t start by buying a big stable. My wife began teaching out of a converted curling rink on a chicken farm for the farmer’s kids. Years later, after she’d built up a reputation and a cliental, and after boarding our own horses for more than a decade, we moved on to the next step and bought a property. Even that though, isn’t the “perfect” place. There are issues with it that may cost us certain clients. The difference is, it’s been slowly build up to function within our financial limitations. Many competing stables are funded by an outside source of income (a lot are tax write-offs for successful doctors/lawyers/businessmen who’s kids grew up wanting to ride). I didn’t come from that path, so I can’t throw buckets of money at it for clients to ride in tropical environments at my expense, while walking on marble tiled floors and pristine stalls lined in quilted padding… We know what we can provide, and it has to appeal to people at a certain price point. I can’t charge 1000’s of dollars for board, the market won’t support it.

I think the reason why many people fail in business and investing is that they try to force what they want out of a market that doesn’t want to support those demands. People have to think about the problem in reverse. For real estate, that means starting with “what is the bottom price for rent in a bad economy” and figuring out how much you can buy a place for from that. Using the 1% rule, if rent is $500 in a bad economy, you shouldn’t pay more than $50–55,000. Ignore what the realtor tells you about “good investments” (they make their money from selling bad ones over and over again). Can’t find anything in that price range? Then wait, and keep looking.

In business, figure out how you make your money, where it’s coming from, who your clients are and what do you need to do to keep them coming back. You can’t please all of them, and you’re going to always lose some, but your goal should be to keep replacing those losses. If you try to keep everyone happy, you’re going to fail. Of course, that doesn’t mean you rest on your laurels. You need to evolve your business constantly, look for new income streams, new services, ways to improve customer care…but don’t just fall back on cash injections or amputations.

Lesson: Many businesses fail because people try to cure the problems by symptom control rather than diagnosing the disease and treating it.

In April I wrote an article called “Warning Signs — Time to move”, and a reader just asked if my views had changed since then, so here’s an update.

In rereading the article, I’d say much of what I wrote has come to pass. Interest rates have risen a bit (about 3.57% is now normal for a 5 year fixed) and, as predicted lending has tightened up.

I recently met with a bunch of other investors who’ve been trying to get mortgages (now, these are successful real estate investors, not new people with no track record) and they’ve found getting mortgages to be a real pain in the butt. Some of the typical excuses:

The property is too small

The loan value is too small

Your current properties can’t service their current mortgages and you’re underwater, so you can’t qualify for more loans (Personally I like this one the best, as the rents seemed to have covered the debt servicing when they got the mortgages, they’d never missed a payment, and they’d increased rents since originally qualifying, plus the bank can see the account rising as the profits flow in)

You’ve reached the limit in the number of properties you can own (when the same bank funds others with many more properties)

We want to see your…fill in the blank for some weird piece of financial information. After you provide it, they’ll repeat this step until you give up.

Something similar happened in the USA after the financial meltdown. Congress awarded the American banks a huge bailout with the expectation that they’d lend it out and get the economy moving again…only the banks didn’t lend it out. Sure, they made it look like they had the money available, they just never seemed to find the “qualified” candidates.

Now, this is not to say you can’t get a loan. I’ve found if you push hard enough (and maybe threaten to move your assets to a different institution) they will relent and lend you something.

I know an investor who did this very thing, and were approved for a loan based on the revenues the property generated. When the appraisal came in, they only used half the pre-approved limit. A month later, he had a second property (which would generate more income) which came in under the other half of his pre-approved loan based on the first property’s income. Ironically, the bank then said there’d be no more loans as the income didn’t support it. He pointed out that the last month the income would have covered it without the new income, and wouldn’t take no for an answer…he won, but it took a long time and a lot of hassle.

Now, the reader also asked what I thought about being mortgage free, investing elsewhere and then waiting for the “bust” to acquire a primary residence and rentals.

To address this, I’d like to point out something…not everyone is going to make money in real estate. It’s not because you can’t make money, nor is it because real estate investing is risky, it’s because people are stupid and don’t treat it like a business.

9 out of 10 businesses fail within a few years. In my experience this isn’t because running a business is hard, it’s because people don’t know how to do it and can’t figure it out. Every employee I’ve ever met thinks they know how to run a business and what’s involved. Many don’t understand that they get paid if they are working or goofing off (until they get fired at least), but the company only gets paid if it produces/sells/whatever. There is much more to running a company (taxes, overhead, management, planning, market evaluation, etc) than most people ever see.

My sister-in-law used to be a BIG TIME union supporter, wanted minimum wage raised to $20/hr, thought they were exploited, etc…until she was promoted to management and saw the other side of things. Of course she still longs to be a union employee even though she despises them because of what a “cushy, protected, job they have”.

Running a business isn’t easy, neither is real estate. You can’t pick a price for your product that you want your customers to pay, you have to figure out the price the market wants to pay for the product or it won’t be successful (I’m sure Coke would love for you to pay $20/can instead of $1, but life doesn’t work that way). Yet, ironically, many people who try to invest in real estate seem to think this way…

I bought a place for $250k, put $50k of renovations into it, but I couldn’t find any renters who’d even cover the payments…real estate investing sucks! You can’t make money in it.

The successful investor looks for the property which will make money, not in the boom times, but in the bust times. The people I know buying right now are picking up places at below $100k/door, renting them out at prime rents and making a killing.

When the bust hits, property values will fall. Most of the properties being bought at these levels are already significantly below market, but I expect their values may also decline…but with people losing their homes, what happens to demand on the rental market which is already floating at around 1.5% vacancy?

If your home was mortgage free, and the bust hits, you’re home’s value will also decline as the market is flooded with houses. Your equity (cash) will disappear overnight what happens to your equity?

Let’s look at what can happen, assuming no more money goes into they system, we’ll only work with home equity.

1) You lived in a $200k house, but really wanted a $300k house so you wait for the bust (lets say 50%). The house you wanted is now $150k, but yours is only worth $100k (you can upgrade for $50k (total cash in $250k), but you lost $100k on top of that, so the house $150k actually cost you the equivalent of $250k. In this case you have 1 property worth $150k with a mortgage of $50 to pay down.

2) Had you sold your 200k house and bought the 300k one it would have only cost you $100k ($300k total), but you would have lost $150k is the bust), so you have 1 property worth $150k with a $100k mortgage to pay down, no cash flow.

Now, had you leveraged your home in the boom, and bought multiple cash flowing properties (cheap, yes they are hard to find, but if you buy high you’ll lose your shirt) and can generate a positive cash flow, you’ll easily make your payments and the bank probably won’t care since they have so many others in real default. On paper, you may have lost equity, but from a cash flow perspective you’re laughing.

Lets look at this scenario…

3) You live in a 200k house, leverage $150 and buy two rentals at 75k (25% below current market values) generating $1000/month rent each, $500/month profit (I’m going with easy numbers) after paying the loan. Total value of real estate in the boom $350k. Bust hits your place is now worth $100k and your two rentals are worth $50k each (as they were already 25% below market, they didn’t fall as far). Total cash lost $0…yes, you’ve lost $50k on paper but it’s not realized until you sell (in the above examples where you upgraded, while it’s also technically on paper, you really lost 100k as you can’t even leverage it anymore). You still owe the bank $150k but the rentals are paying for it, your real estate is worth $200k, and two properties are generating $1,000/month income. On the rebound you’d have 3 properties increasing in value.

4) For a final scenario, lets assume you got 50% mortgages on the rentals and so were able to buy 4 for the same $150k instead of two. You’d owe $300k (paid for by the rentals), but own $300k in real estate after the bust with 4 cash flowing properties loan is being paid, you’re making $2,000/month profits and have 5 properties to benefit from the recovery.

Summary:

Scenario 1 your $200k became $100k (on paper) that doesn’t earn any income and you need to pay off $50k, negative income and return.

Scenario 2, your 200k became $50k (on paper)and you need to pay off $100k, negative income and return.

Scenario 3, your $200k became $50k (on paper) but pays you $12k/year (6% return) and you have 3 properties to benefit from a recovery.

Scenario 4, your $200k becomes $0 (on paper) but pays you $24k/year (12% return) and you have 3 properties to benefit from a recovery.

Which is the “right” scenario? I suppose it depends on your needs and comfort. In a bust economy you’re going to lose money on paper if not in reality. This wasn’t a “planned” blog entry, The numbers were generated as I wrote the article, so I wasn’t planning on saying one way was better than the other…it’s just outlining what would happen.

In the first two scenarios, you can see the effects of what I call “dead money”. In a bust, you protected the banks from the loss, and it doesn’t earn you anything.

When I look at the other two scenarios, even though on paper the same or more money disappeared, their earning power didn’t. As long as you don’t sell and lock in your losses, you are still generating a fairly good return on $200k as if it still existed.

If you needed the cash quickly, real estate isn’t the place to be invested, as you can see the money all but disappeared, but the thing I like about real estate is that it works like “virtual money”. You’re making money out of nothing. In future years, if you project them out, I think you’ll be amazed at the growth of your net worth in Scenario 4, but it won’t happen quickly, not at first anyway.

To be successful in real estate, you need to have the long term view. Losing money on paper isn’t that bad in my opinion if the earning power of that money still exists, but then I’m a buy and hold investor in everything.

One more thing to consider, if the market is in bust, and banks are sitting on a pile of bad loans, how eager are they going to be to finance new ones? If you plan on cashing in after the bust, you may be out of luck.

Lesson: Real estate, though a game, has to be treated like a business to succeed. Which way you choose to go depends on your investing style and comfort.

I’ve never been a big fan of flipping houses, but I know people who do it. Trying to find a good place at the right price is tough in this economy and market, and finding one you can add value to and sell at a profit is even harder.

Flipping houses is not an investment, it’s gambling. There are too many factors in the market that you can’t control, think 2007.

When you add in the realtor fees, the time the money for supplies, it’s rare you can make it work.

For those who do make it work, Revenue Canada has taken away a big chunk of your rewards. Unlike real estate investing, where you claim the profits as tax favourable Capital Gains, house flipping isn’t considered investing by Revenue Canada either, and you should be claiming profits as income (as in you’re taxed at the highest rates).

For more information on this, here’s an article from the financial post. Note, they are talking about pre-built condos, but I’m sure Revenue Canada looks the same way upon flipping older places as well (though you should be able to write off the expenses).

It’s been a busy time over the past few months, but I’ve learned a few things along the lines…

Getting better value, faster

I’ve always advocated financing a rental 100%, but these past few months I’ve learned a little trick I didn’t know before. In the past, I knew that if you bought a property and you wanted a mortgage, the selling price you paid was pretty close to the top-of-mark that you would get. If you could wait six months and refinance, the bank would send out an appraiser (who, while influenced by your purchase price, would usually give you a price closer to market value). This could really make a difference in the amount of financing you could get. For example, let’s say you found a place which you could buy for $75,000, but other, similar, properties are selling for $100,000. If you applied for a mortgage right away, the bank would use your purchase price ($75k) and give you let’s day 75% financing on it ($56,250). After owning it for six months, the bank would send out an appraiser who said the property was worth $100k, then you could get 100% of your purchase price financed because 75% of the appraised value (100K) is $75,000. So, originally, I thought get a short mortgage for 6 months to a year and then refinance your purchases.

The trick I learned recently though, is if the property is clear title (no existing mortgage), the bank needs to send out an appraiser for it, even if you only bought it a day before. So, how can you do this? If you have a different source of financing (say a HELOC on your primary home) which can pay for the property outright, you can then start financing it as soon as the day after you purchase your property. So, to continue the above example, if I bought the property using my HELOC and paid $75k on my line of credit, I could approach the bank the day after I closed to finance a “clear title” property, for which they’d send out an appraiser. Now, to be fair, bank appraisers in general are very conservative, and I’ve found are still heavily influenced by your purchase price, but there still is a higher likelihood of getting a price closer to market value.

NOTE: Before people complain that there are no properties available in this market selling below market value, let me tell you that there are. They aren’t easy to find, you have to work and be ready with your financing, but I’ve made several such purchases in the past year alone.

Insurance Savings

Things I’ve learned…

Call Around Yearly

The next tricks I learned recently, or more accurately rediscovered, was to shop around for insurance. As I stated above, I’ve recently made a number of acquisitions, so I needed to get them insured. As my original policy was coming due anyway, I decided to make some phone calls (something I’d neglected to do over the last couple of years, because I thought I was too busy). In calling several brokers, I was amazed at all the different price quotes I got. I was also amazed that most brokers only called one or two insurance companies (I’m thinking better kickbacks as a possible reason). After a while, I started to get feedback that I’d already been quoted using someone else, so I knew I could probably stop shopping around. The final results were amazing. Some quotes were up to 7 times more expensive than others for basically the same coverage.

Personal vs. Corporate

A while back, I had to “upgrade” my policy to a commercial account because my broker told me I had too many properties to keep them under a personal account. It turns out this was true, for that particular insurance company. I called up a different broker, and they found me a company which would insure them all, no limit, as personal properties. The savings on switching back were nearly 50% alone, plus the coverage was technically greater on the property.

Lower content coverage on Condos

If you own a condo, you have three levels of insurance you need to be aware of. Your tenants need Tenant Insurance (to cover their stuff and liability), the Condo need Condo insurance (to cover the building and catastrophic liability) and then you still need owner’s insurance (sort of in between the other two and to cover your liabilities). Now, one of the items you get covered in a standard policy is contents and upgrades, and most times they have it at the same level as your purchase price. For a house, this makes sense, for a condo it’s plain stupid. The insurance will usually cover the cost to rebuild the place back to the original standard. If you bought an older place, and upgraded the interior, you may want to have these upgrades covered so you don’t get gold shag carpet put back in… But the minimum coverage of $25,000 would probably more than cover the cost of material upgrades and installation, no need to get more.

Also, as far as contents go, unless you are supplying a furnished apartment, I wouldn’t even bother with this. on my places I only supply appliances, which can be easily replaced for very little money compared to the insurance premiums which would only cover them in case of a catastrophic disaster (such as the place burning down). In those cases, it’s probably better to pay for a “loss of rent” rider which pays you the lost rental income while the place is being rebuilt (remember the bank still wants you to pay the mortgage even though the property is being rebuilt). Well, I’ll try to get back to writing a bit more regularly again, hopefully things will die down a bit more in the next little while and give me some more time.

Lesson: There are always new tricks to learn which will make you more money, never believe you know everything there is to know, and never forget to do the things you already know, even if you think you’re too busy.